The optimal taxation of unskilled labor with job search and social assistance

In order to explore the optimal taxation of low-skilled labor, we extend the standard model of optimal nonlinear income taxation in the presence of quasi-linear preferences in leisure by allowing for involuntary unemployment, job search and an exogenous welfare benefit. In trading off low-skilled employment against work effort of higher skilled workers, the government balances distortions on the search margin with those on work effort. Higher welfare benefits typically reduce taxes paid by low-skilled workers and raise marginal tax rates throughout the skill distribution.     

Optimal climate and fiscal policy in an OLG economy

This paper develops a climate–economy model to study the joint design of optimal climate and fiscal policies in economies with overlapping generations (OLGs). I demonstrate how capital taxation, if optimal, drives a wedge between the market costs of carbon (the net present value of marginal damages using the market interest rate) and the Pigouvian tax (the net present value of marginal damages using the consumption discount rate of successive OLGs). In contrast to deterministic infinitely lived representative agent models, at the optimum, the capital income tax is positive, the carbon price equals the market costs of carbon but it falls short of the Pigouvian tax when (i) preferences are not separable over consumption and leisure; and (ii) labor income taxes cannot be age-dependent. I also show that restrictions on climate change policy provide a novel rationale for positive capital income taxes.     

Second-best optimal taxation of capital and labor in a developing economy

As commercial integration reduces the reliance on foreign trade taxation, raising tax revenue has become a major concern for the governments of developing economies. This paper examines how the tax burden in a developing economy should be distributed between capital income and labor income. We study a two-sector model, where the traditional sector is “informal” and consequently cannot be taxed by the government. In this setup, we find that the optimal (second-best) tax structure in order to raise a certain amount of revenue requires to tax capital income at least as much as labor income, and possibly more.     

Optimal Taxation and Monopsonistic Labor Market: Does Monopsony Justify the Minimum Wage?

Does monopsony on the labor market in itself justify the implementation of a minimum wage when it would not be used in a competitive economy? This issue is studied in a model of optimal taxation. We find that there is no room for the minimum wage when there are a continuum of skills with no isolated mass point at the bottom of the wage distribution. Accordingly, in the empirically relevant situation, where there is a continuum of wages at the bottom of the distribution, the minimum wage is not helpful.     

Equilibrium capital taxation in open economies under commitment

This paper analyzes equilibrium capital taxation in open economies with strategic interaction in a neo-classical growth model. Under perfect commitment, I show that non-cooperative capital taxes are zero in the long run for a large open economy, thereby generalizing the result previously established only for the special cases of a closed and a small open economy. This does not represent a race to the bottom, though, since the result is independent of the degree of capital mobility, the number of countries, or a country׳s size relative to the rest of the world. Moreover, when countries cooperate, they still set capital taxes to zero in the long run. These outcomes are robust to different equilibrium specifications, the inclusion of endogenous government spending, and heterogeneous agents and non-linear labor income taxation. Governments find it optimal to implement the efficient capital allocation in the long run, both in a closed and an open economy; this trumps incentives to tax foreigners’ domestic capital holdings by raising capital taxes and attracting capital from abroad by lowering capital taxes.     

Risky human capital and deferred capital income taxation

We study the structure of optimal wedges and capital taxes in a dynamic Mirrlees economy with endogenous distribution of skills. Human capital is a private, stochastic state variable that drives the skill process of each individual. Building on the findings of the labor literature, we construct a tractable life-cycle model of human capital evolution with risky investment and stochastic depreciation. In this setting, we demonstrate the optimality of (a) a human capital premium, i.e., an excess return on human capital relative to physical capital, (b) a large intertemporal wedge early in the life-cycle, and (c) a non-zero intratemporal wedge even at the top of the skill distribution at all dates except the last date in the life-cycle. The main implication for the structure of optimal linear capital taxes is the necessity of deferred taxation of physical capital. The average marginal tax rate on physical capital held in every period is zero in present value. However, expected capital tax payments do not equal zero in every period. Necessarily, agents face negative expected capital tax payments early in the life-cycle and positive expected capital tax payments late in the life-cycle.     

Optimal non-linear income taxation for reduction of envy

This paper examines the optimal non-linear income taxation problem based on λ-equitability. An allocation is λ-equitable if no agent envies a proportion λ of the bundle of any other agent. We examine the properties of Pareto undominated allocations for various λ-equitability requirements. When there is one output, the marginal income tax rate can increase only if leisure is a luxury. In a multi-commodity model with commodity taxes, the goods preferred by the low skilled agent and/or those with high Hicksian elasticities are taxed more heavily. When preferences exhibit quasi-linearity, we can show that the introduction of the λ-equitability constraint increases the marginal income tax rates of the entire population.     

Environmental taxes with heterogeneous consumers: an application to energy consumption in France

This paper constructs a model with four groups of households who have preferences over labor supply, consumption of polluting (energy related) and non-polluting (non-energy) goods, and emissions. It quantifies the model for the French economy and computes its optimal tax equilibria under nine second-best tax regimes. We find that the redistributive role of environmental taxes requires the polluting goods to be taxed at a rate much below their marginal social damage. These goods may even require an outright subsidy if the society values equality ‘a lot’. Secondly, if environmental taxes that have an exclusively externality-correcting role, they benefit all types—although the gains are rather modest. The gains and losses become more substantial when environmental taxes have a redistributive role as well. Third, setting the environmental tax at its Pigouvian level, rather than its optimal externality-correcting-cum-redistributive level, benefits the high-income group at the expense of the low-income groups. Fourth, nonlinear taxation of polluting goods, and nonlinear commodity taxation in general, is a powerful redistributive mechanism. Fifth, introducing environmental taxes in the current French tax system, with its suboptimal income taxes, results in substantial welfare gains for the highest income group and a sizable loss for the least well-off persons.     

Taxing the Financially Integrated Multinational Firm

This paper develops a theoretical model of corporate taxation in the presence of financially integrated multinational firms. Under the assumption that multinational firms use some measure of internal loans to finance foreign investment, we find that the optimal corporate tax rate is positive from the perspective of a small, open economy. This finding contrasts the standard result that the optimal‐source‐based capital tax is zero. Intuitively, when multinational firms finance investment in one country with loans from affiliates in another country, the burden of the corporate taxes levied in the latter country partly falls on investment and thus workers in the former country. This tax exporting mechanism introduces a scope for corporate taxes, which is not present in standard models of international taxation. Accounting for the internal capital markets of multinational firms thus helps resolve the tension between standard theory predicting zero capital taxes and the casual observation that countries tend to employ corporate taxes at fairly high rates.     

Optimal taxation with consumption time as a leisure or labor substitute

This paper studies the optimal commodity taxation problem when time taken in consumption is a perfect substitute for either labor or leisure. It shows that while labor substitutability affects the optimal tax structure, leisure substitutability leaves the classical optimal tax results intact. In the Ramsey tax framework with linear income taxes, whether the consumers have the same or different earning abilities, labor substitutes tend to be taxed at a higher rate than leisure substitutes with the tax differential being increasing in consumption time. This is not necessarily the case when one allows for nonlinear income taxation.     

Optimal incentives for labor force participation

Optimal taxation is analyzed under a Rawlsian criterion in an economy where the only decision of the agents is to participate, or not, to the labor force. The model allows for heterogeneity both in the agent's productivities and aversions to work. At a first-best optimal schedule, the marginal agent who decides to work pockets all of her productivity, while being just compensated for her work aversion. When the planner does not observe work aversion, financial compensation for work is lower than productivity. Theory puts little restrictions on the shape of the optimal tax schedules. The usual first-order conditions involving the elasticities of participation only apply for sufficiently regular economies. We qualitatively show how the optimal incentive schemes depend on the underlying structure of the preferences: 100% marginal tax rates or subsidies to work are related to specific features of the economies.     

Optimal Taxation in Life-Cycle Economies

We use a very standard life-cycle growth model, in which individuals have a labor-leisure choice in each period of their lives, to prove that an optimizing government will almost always find it optimal to tax or subsidize interest income. The intuition for our result is straightforward. In a life-cycle model the individual's optimal consumption-work plan is almost never constant and an optimizing government almost always taxes consumption goods and labor earnings at different rates over an individual's lifetime. One way to achieve this goal is to use capital and labor income taxes that vary with age. If tax rates cannot be conditioned on age, a nonzero tax on capital income is also optimal, as it can (imperfectly) mimic age-conditioned consumption and labor income tax rates. Journal of Economic Literature Classification Numbers: E62, H21.     

Effects of subsidies on growth and welfare in a quality-ladder model with elastic labor

This paper develops a quality-ladder growth model with elastic labor supply and distortionary taxes to analyze the effects of different subsidy instruments: subsidies to the production of final goods, subsidies to the purchase of intermediate goods, and subsidies to research and development (R&D). Moreover, the model is calibrated to the US data to compare the growth and welfare implications of these subsidies. The main results are as follows. First, we analytically show that an optimal coordination of all instruments attains the first-best outcome. Second, in the calibrated economy, we numerically find that for the use of a single instrument, R&D subsidy is less growth-enhancing and welfare-improving than the other subsidies, whereas for the use of a mix of two instruments, subsidizing the production of final goods and the purchase of intermediate goods is most effective in promoting growth but least effective in raising welfare.     

Aggregate instability under balanced-budget consumption taxes: A re-examination

We re-examine the destabilizing role of balanced-budget fiscal policy rules based on consumption taxation. Using a one-sector model with infinitely-lived households, we consider a specification of preferences derived from Jaimovich (2008) [14] and Jaimovich and Rebelo (2009) [15] which is flexible enough to encompass varying degrees of income effect. When the income effect is not too large, we show that there exists a Laffer curve, which explains the multiplicity of steady states, and that non-linear consumption taxation may destabilize the economy, promoting expectation-driven fluctuations, if the elasticity of intertemporal substitution in consumption is sufficiently larger than one and the tax rate is counter-cyclical with respect to consumption. Numerical illustrations also show that consumption taxation may be a source of instability for most OECD countries for a wide range of structural parameters? configurations. We finally prove the robustness of our conclusions if we consider a discrete-time setup.     

Gender differences in the volatility of work hours and labor demand

This paper examines the role of heterogeneity in a real business cycle model, which traditionally has not fully captured the relative volatility of hours to output. Men and women have different cyclical volatilities in hours worked, which is robust to different filtering methods. This empirical regularity is used to motivate a standard RBC model augmented to allow for two different agents following Jaimovich et al. (2013). These two agents have identical utility functions, but face different elasticities of labor demand due to their different complementarities with capital. These estimated elasticities find that women are more complementary to capital. The calibrated model generates the cyclical volatility of work hours by gender and for the total hours worked that matches the U.S. data better than the traditional representative agent model. I then explore other extensions to this model including investigating the stability of the estimated labor demand elasticities and allowing for various Frisch elasticities of labor supply. This paper demonstrates that allowing for even broad levels of heterogeneity in a simple framework can increase the model’s tractability with the data. Since gender is important to explain U.S. business cycle dynamics, we need to carefully consider heterogeneity when analyzing counter-cyclical economic policy, as it may not have symmetric effects across assorted groups.     

Intertemporal labor supply and involuntary unemployment

We estimate a model of intertemporal male labor supply behavior which explicitly accounts for the effect of income taxation and the transfer system. Moreover, we model the demand-side driven rationing risk that prevents agents from choosing the optimal labor supply state. Our results show that elasticities derived in an unconstrained pure choice model are significantly higher compared to a model with involuntary unemployment. This holds true for short-run and long-run labor supply elasticities.     

Optimal oil taxation in a small open economy

The international oil market has been very volatile over the past three decades. In industrialized economies, especially in Europe, taxes represent a large fraction of oil prices and governments do not seem to react to oil price shocks by using oil taxes strategically. The aim of this paper is to analyze optimal oil taxation in a dynamic stochastic general equilibrium model of a small open economy that imports oil. We find that in general it is not optimal to distort the oil price paid by firms with taxes, neither in the long run nor over the business cycle. The general result could be reversed depending on environmental considerations and available fiscal instruments. We provide simulations to illustrate the optimal response to shocks in such cases.     

Tax Rate Variability and Public Spending as Sources of Indeterminacy

We consider a constant returns to scale, one sector economy with segmented asset markets of the Woodford type. We analyze the role of public spending, financed by labor income and consumption taxation, on the emergence of indeterminacy. We find that what is relevant for indeterminacy is the variability of the distortion introduced by government intervention. We show that the degree of public spending externalities in preferences affects the combinations between the tax rate and its variability under which indeterminacy occurs. Moreover, we find that consumption taxes can lead to local indeterminacy when asset markets are segmented.     

What Should Optimal Income Taxes Smooth?

According to the theory of tax smoothing, income tax rates should be kept constant so as to minimize the distortionary costs of taxation. By explicitly considering how labor supply is distorted by income taxes in a fully specified intertemporal model, we find that the optimal income tax policy should smoothen leisure. In the case of varying income (productivity changes) this is attained by a pro‐cyclical (progressive) tax rate.     

Time‐consistent optimal fiscal policy*

This article studies the properties of optimal fiscal policy in a stochastic growth model when the government cannot commit itself beyond the next period's capital income tax rate. We find that the results contrast markedly with those under full commitment. First, capital income tax rates are very high (65% on average versus close to zero on average under full commitment). Second, labor income taxes are rather low on average (about 12% versus a value of around 31% under full commitment). Finally, labor income taxes are quite volatile, whereas under full commitment their standard deviation is essentially zero.